Stamina, Not Speed

By Stephen Koepp

Like a runner trained for long distances, America's economic expansion is showing remarkable staying power, if not robust speed. The U.S. recovery, which passed the four-year marker in November, just keeps chugging ahead in spite of ever present doubts and dangers along the road. Since its start in 1982, the expansion has been refreshed at crucial intervals, first by the plunge of interest rates and later by the fall of oil prices. Now, at 49 months and counting, the durable recovery is already the second longest peacetime boom in U.S. history, after the 58-month expansion in 1975-79.

And the economy is expected to keep on kicking long enough to break that record. TIME's Board of Economists, which met last week in Manhattan, predicted that America's gross national product will expand another 2.8% during 1987, compared with an estimated 2.4% this year and 2.9% in 1985. "I see no real break in the stride of the expansion. It will be long but not strong," said Board Member Walter Heller, who served as chairman of the Council of Economic Advisers for Presidents Kennedy and Johnson.

The forecast for further growth largely rests on the increasing conviction that the U.S. has started to make progress against its most draining economic problem: the huge trade gap. For the most part, that gap is the legacy of an American dollar that was too strong in the first half of the decade. That made foreign goods cheap in the U.S. and U.S. exports too expensive in other countries, and the resulting trade imbalance has created a heavy drag on growth. But in recent weeks economists have become persuaded that the nearly two-year decline in the U.S. dollar may have finally triggered a turnaround in trade. "I think the data clearly show a cresting in the deficit," said Alan Greenspan, former chief economic adviser to President Ford. After hitting an estimated $165 billion for 1986, a record total, the trade gap could shrink to about $140 billion next year.

Yet the deficit has already reached such a high level that it will remain a burden next year. Said Greenspan: "Unlike any time in recent American history, the outlook for the domestic economy is being driven by our international accounts." Indeed, last week the Reagan Administration, citing % the troublesome trade situation first among all factors, lowered its economic- growth projection for 1987 from 4.2% to 3.2%.

The U.S. particularly needs to improve its export sales, because the economy is unlikely to benefit from any significant gain in spending among American consumers next year. Since the recovery is so far along, much of the demand for major items, such as houses and autos, that built up during the last recession has been satisfied. While consumers remain fairly confident, they have already gone on an extended shopping spree paid for by a heavy load of installment debt. Just this past fall, millions of consumers rushed to the auto showrooms to take advantage of cut-rate financing offers. "They won't head for the hills now, but they will pull in their horns a little," said Heller. This season's Christmas receipts are expected to be good but not glorious; last week the Commerce Department announced that retail sales in November posted a .5% gain over the previous month.

TIME's board believes inflation will increase substantially next year, from an estimated 1.8% in 1986 to 4% in 1987. One reason: the declining value of the U.S. dollar will continue to make imported goods more expensive. Another contributing factor is that the Consumer Price Index will no longer be pulled downward by the epic plunge in oil prices that occurred in early 1986. Last week the Organization of Petroleum Exporting Countries convened in Geneva to fashion a strategy for pushing up crude prices from $15 per bbl. to $18 per bbl., but economists generally believe the cartel's efforts will be insufficient to rekindle serious inflation.

Most experts are not overly alarmed by the prospect of 4% inflation next year. It may in fact boost morale for U.S. businesses, many of which have been beleaguered by falling prices and profit margins. Said Greenspan: "A mild dose of inflation will be perceived, at least temporarily, as a very expansionary, stimulative force."

If inflation remains modest enough, interest rates should hold fairly stable. TIME's economists predicted that the benchmark prime lending rate that banks charge corporate customers will stay at about its current level of 7.5% through 1987. The Federal Reserve Board has kept a rather loose rein on the money supply this year, and is giving no hints that it will change that position anytime soon. By keeping the economy moving, that policy should help chip away at the U.S. unemployment rate, which has been stuck at 7% for the past three months. While TIME's board expects joblessness to ease only slightly in 1987, to about 6.8%, even that small decrease would provide roughly 200,000 more jobs.

Early next year the economy will face an entirely new and so far unmeasured influence: federal tax reform, which goes into effect Jan. 1. Some economists have predicted a dip in the economy as the tax package begins its five-year shift of $120 billion of the tax burden from individuals to corporations, notably by phasing out many credits for investment in plant and equipment. Those changes will reduce incentives for capital spending and could make the U.S. less attractive than some other countries as a place to locate factories and offices. "On balance, this is a capital-exporting tax bill," said Harvard Professor Martin Feldstein, who served for two years as President Reagan's chief economic adviser.

Even so, TIME's board generally agreed that the negative impact of tax reform on some businesses may be mostly outweighed by stimulative effects. For example, the tax package will immediately give many consumers more money to spend after Jan. 1, when withholding rates will begin to decline. Concluded Heller: "The projected tax-reform slump won't live up to its advance notices."

The economy's all too real nemesis remains the trade gap. TIME's board members give the Reagan Administration credit for beginning to confront the problem in September 1985, when Treasury Secretary James Baker joined an effort by industrial countries to push down the value of the U.S. dollar. Since its peak in February 1985, the greenback has declined 38% against the Japanese yen and 42% against the West German deutsche mark. That trend has begun to make American-made goods more competitive in price with foreign products. In October the U.S. merchandise trade deficit declined to $12.1 billion, from $14.7 billion the previous month, according to initial Government estimates.

Virtually all economists agree that the easing of the trade problem has barely begun. The dollar must decline more, perhaps as much as 30%, in order to bring U.S. trade eventually into balance. Yet this close watch on the dollar, ironically enough, has produced a brisk debate about just where the greenback now stands against the world's currencies. A widely monitored Federal Reserve index of the dollar's value compared with that of other major currencies has plunged some 35% since early last year, but Irwin Kellner, chief economist for Manufacturers Hanover Trust and a guest at TIME's board meeting, holds a sharply different view. By Kellner's calculations, the dollar has fallen only about 5% overall, after adjustment for inflation.

The Fed's index is way off, contends Kellner, because it is based on out- of-date U.S. trading patterns from the 1970s and focuses too much on trade with Europe and Japan. Kellner's bank has developed a revamped index that takes into account increased U.S. trade with other Asian countries and Latin America, against whose currencies the dollar has not moved or has actually drifted upward recently.

Other members of TIME's board believe that Kellner's index sharply underestimates the degree to which the dollar has already declined. By Feldstein's accounting, the dollar declined a substantial amount, about 24%, between February 1985 and July 1986. Unlike Kellner, whose calculations give greater weight to the currencies of countries that trade heavily with the U.S., Feldstein puts emphasis on currencies according to their importance in total worldwide trade. Feldstein feels this is the most valid way to measure the greenback, because U.S. merchandise competes with foreign products not only in the countries in which they are made but in many other markets. Even so, Kellner's controversial index makes a valid point that the U.S. needs to strengthen its effort to encourage such countries as Canada, Taiwan, South Korea and Singapore to boost the currencies. Otherwise, U.S.-made goods will remain uncompetitive with products from those nations.

At the moment, the Administration is keeping up heavy pressure on the major industrial countries to become more receptive to U.S. merchandise by stimulating their economies and lowering trade barriers. "They listen to us, but they haven't found a way yet to change their domestic policies," said Board Member Rimmer de Vries, chief international economist for Morgan Guaranty Trust. "There is very little growth outside the U.S."

TIME's board members expressed hope that the improving trade deficit would dampen sentiment in Congress next year to produce a barrier-laden trade bill. Yet Congress may be tempted to pass protectionist measures under the cover of the new, sexier buzz word of competitiveness, according to Board Member Charles Schultze, a senior fellow at Washington's Brookings Institution and former chief economic adviser to President Carter. Schultze warned that under the patriotic banner of competitiveness, overzealous legislators may fail to differentiate between healthy steps to boost efficiency (example: increased worker training) and potentially harmful measures to shelter industries (example: quotas on foreign products). The most effective way for the U.S. to become more competitive abroad, Schultze pointed out, is to concentrate on making its goods less expensive by bringing the dollar into line.

Congress could help reduce the too high dollar by cutting the federal budget deficit, which hit a record $221 billion in fiscal 1986. The Treasury's need to attract foreign money to finance this deficit keeps interest rates in the U.S. high compared with other countries. That in turn puts upward pressure on the currency, because so many investors are buying up dollar-based securities. But TIME's board expects the slow progress in making budget cuts to continue next year. The deficit in fiscal 1987, which ends next October, will probably ease to $190 billion -- still well above the $144 billion target established by the Gramm-Rudman deficit-reduction law. The economists believe the Iran-contra scandal, among other issues, could distract congressional attention from the job of slashing the fiscal 1988 budget.

The twin deficits -- budget and trade -- have created a historically unprecedented pile of external U.S. debt. America now owes foreign creditors nearly $200 billion, making it the world's largest debtor country. If trade deficits were to continue at their current level, the debt could reach $800 billion by 1991, Feldstein estimated. More ominous, U.S. debt could suddenly hit a critical point at which foreign investors become concerned that their money is concentrated too much in one place. Any sudden loss of confidence, said De Vries, could send the dollar into a steep fall. A plunge in the dollar could ignite a run-up of interest rates and a recession. Said De Vries: "It's going to take a miracle to solve this problem without a really significant slowdown in the U.S. economy, but I don't think it's around the corner."

TIME's economists expect that foreign resistance to U.S. debt is more likely to grow gradually, allowing the dollar to decline at an orderly pace. Said Feldstein: "I think we can get there without a shock." But even if it happens smoothly, the necessary further decline of 20% to 30% in the dollar will be bitter medicine for U.S. consumers. By making imports more expensive, ! the weak dollar will hamper the growth in the standard of living. "There's no question we will be poorer as a nation because of this, or rather we will get richer more slowly," said Feldstein. The trade-off is that even if Americans have to buy fewer Japanese videocassette recorders and German BMWs, a more modest dollar will prevent the U.S. from going disastrously into hock by the end of the decade.